Whether it has one owner or multiple members, an LLC is an entity that is legally distinct from the assets of its ownership. As a result, what happens to the LLC upon the death of the sole member or one of multiple members depends on several factors. Death, unfortunately, is inevitable, and it is therefore an occurrence that should be addressed in the LLC’s operating agreement.
What is an Operating Agreement?
An operating agreement is not required for an LLC but is highly recommended. The operating agreement specifies each owner’s percentage of ownership, their share of profits and losses, rights, roles, and responsibilities, and what happens to the business should a member leave or pass away.
An operating agreement has several benefits:
- Protects your limited liability status, particularly if you only have one member, by firmly establishing your business as a separate entity.
- Clearly defines your management and ownership structure, helping avoid decision-making disputes.
- Overrides the default LLC rules of your state, enabling greater control over roles and profit and loss allocation.
Hiring an attorney to help craft and approve your operating agreement is highly recommended, to ensure you’re covering all bases and protecting all members.
Single Member LLC
An LLC with only one member can survive even if the sole member dies. In such cases, the operating agreement should include a provision that transfers LLC ownership to another person or organization in the event of the owner’s death. This makes the transfer smooth and simple because it is specified in writing.
If there is no provision in the agreement specifying to whom the LLC is to be transferred, the LLC becomes an asset of the member’s estate. This complicates the settling of the estate for heirs because LLC ownership may have to be divided or sold. Both situations can be problematic: in the case of division, management must be chosen; in the event of a sale, the LLC’s value must be determined. State laws may also impact what happens to the LLC as part of the estate, so check with your state to see if it has any special rules regarding the death of the sole member.
The member can also specify in his or her will to whom the LLC should transfer, ensuring a smooth transition should the operating agreement conflict with the will. Another option is to include a provision in the operating agreement specifying that the LLC dies if the owner dies.
An operating agreement is critical for multi-member LLCs, and it should have provisions that specify what happens in the event of each member’s death. Without it, achieving resolution is likely to be rather complicated. What happens to a member’s ownership in such cases will most likely default to the laws of the state in which the LLC was formed.
Provisions may be:
- Surviving members must buy the deceased member’s shares from heirs
- Heirs inherit the financial interests of the shares, but not the management interests
- LLC is to be dissolved and the deceased member’s ownership percentage distributed to the heirs
- Deceased member’s financial and management interests transferred to specific person or organization
Essentially, if all members agree, the operating agreement can specify any feasible legal way to transfer the member’s financial and management interests.
Multi-Member LLC with No Operating Agreement
Again, the transfer in such cases will default to the rules of the state. In some states, the LLC must be dissolved and liquidated if a member dies. In others, this occurs only if the last member dies. In some states, the laws prohibit the transfer of interests without the approval of all surviving members. If the deceased member left his ownership interest in the LLC to beneficiaries, only the financial interests can be inherited, not the management interests.
The Bottom Line
It’s critical that single-member and multi-member LLCs address the issue of a member’s death in its foundational documents, particularly the operating agreement. If you are a member of an LLC with no operating agreement, you can still create one to address this issue and other concerns. It is highly recommended that you have an attorney (find one at Avvo or FindLaw) help you draw up your operating agreement to make sure you’ve covered all the bases and protected yourself and all the LLC’s members.